WeeklyBasis 12/11: Four Reasons Rates Are Rising

The rate climb discussed in recent weeks continues with Conforming 30yr fixed rates .75% higher than all-time lows October 7-8. This means a $184/mo higher mortgage payment for a loan of $417,000, and $323/mo higher for a loan of $729,750. Rates for Jumbo loans above $729,750 are only up .25% because these loans are not being securitized and therefore Jumbo rates are more influenced by banks than bond markets.

But even Jumbo pricing desk managers can’t ignore the ongoing mortgage bond market selloff, which pushes all rate tiers higher. Below are the four main themes driving this along with a preview of the December 13 market week:

(1) Markets expected more, not less, Fed help: 30yr fixed rates touched on all-time lows of about 4% on October 7-8, one week after an NY Fed speech alluded to a second round of rate stimulus known as Quantitative Easing. Mortgage bonds rallied (bringing rates down) thinking the Fed’s “QE2” would again focus on mortgage bonds—remember QE1 was a $1.25 trillion mortgage bond buying campaign from January 1, 2009 to March 31, 2010. But on November 3, the Fed said QE2 would ignore mortgages and only focus on buying $600b+ in Treasuries, prompting a mortgage selloff. Markets will be updated on the Fed’s strategy Tuesday, which is the last Fed rate policy meeting of 2010.

(2) Mortgage bond traders are taking profit: Although the Fed’s mortgage bond buying program (QE1) began January 2009, it was announced November 24, 2008. The smart mortgage bond trade after that announcement was to buy, buy, buy before the Fed drove bond prices up. When bond prices rise on massive buying, rates drop. And rates dropped 1% from the announcement to the first Fed buy date. Now it’s two years later, the Fed has confirmed they’re not as committed to mortgage bond buying (see #1 above), so mortgage bond traders are selling to take profits on this two-year trade. When bond prices drop in a selloff, rates rise.

(3) Economic recovery optimism: Last week investors sold safer bonds and bought riskier stocks markets in response to the Bush-era tax cuts being extended. The theory is that this may help the economy enough to cause the Fed to pull back on their QE2 budget, and this causes investors to sell bonds in search of higher returning securities. It’s caused big firms like PIMCO and JP Morgan Chase to raise 2011 GDP growth estimates by about .5%. Early indicators such as the Fed’s Philadelphia manufacturing survey (aka Philly Fed) have risen sharply in the past two months, so the Tuesday release of November’s Philly Fed survey will be closely watched. If it’s higher again, mortgages would sell and rates would rise. We also have November retail sales Tuesday which will capture early holiday shopping figures to gauge consumer strength.

(4) China-led inflation concerns: Today we learned November year-over-year consumer and business inflation in China was a blistering 5.1% and 6.1% respectively. And this Tuesday and Wednesday we’ll see if U.S. business and consumer inflation is holding or rising. Bonds usually sell on inflation concerns so prices drop and yields (or rates) rise to compensate for expected inflation. Even though we’re likely to see continued flat inflation in the U.S. this week, Chinese inflation is still enough to cause selling of U.S. mortgage and Treasury bonds.

These four themes don’t include an ongoing debt crisis in Europe, and this last factor has taken a back seat in recent weeks. But if this re-emerges as a concern, it could cause a mortgage bond rally again, and rates would drop a bit.

For now, last week’s outlook still seems most plausible: that we level off into a trading range where rates are +/-.25% from current levels for the next 1-2 months.

CONFORMING RATES ($200,000 to $417,000) 0 POINT
30 Year: 4.75% (4.87% APR)
FHA 30 Year: 4.75% (4.87% APR)
5/1 ARM: 3.5% (3.61% APR)

SUPER-CONFORMING RATES ($417,001 to $729,750 cap by county) 0 POINT
30 Year: 5% (5.12% APR)
FHA 30 Year: 4.75% (4.87% APR)
5/1 ARM: 3.875% (3.99% APR)

JUMBO RATES ($729,751 to $2,00,000) 1 POINT
30 Year: 5.5% (5.63% APR)
5/1 ARM: 4.125% (4.24% APR)